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Offshore Distribution Centres: What are the Risks?

1 September 2014

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Offshore Distribution Centres: What are the Risks?

Supply chain consolidation through offshore distribution centres is reducing international supply chain costs but may be increasing exposure to the risks of customs non-compliance.

An increasing number of companies are achieving supply chain efficiencies by establishing a regional distribution/consolidation centre or hub (DC). However, we are increasingly seeing sophisticated supply chains being set up without enough attention being given to the customs implications. Not only does this result in reduced levels of customs compliance, but may also result in customs duty being overpaid.

An offshore DC usually functions to receive goods from multiple suppliers and coordinates the consolidation and distribution for shipment to one or more countries. Objectives of off-shore consolidation include ensuring full container loads, or to bypass or shorten the domestic supply chain. In some cases, the distribution centre may perform a buy/sell or ordering function in addition to value add services, such as attaching pricing tags or labelling cartons.

The performance of these roles may lower supply chain costs, but come with frequently overlooked risks. Examples include:

Incorrect use of free trade agreements

Use of incorrect Customs value

Reporting of incorrect information to Customs

Poor customs compliance is not only a threat to a company’s supply chain, but can also prevent traders from taking advantage of the benefits of participating in the proposed trade facilitation programs.

The issues

Managing trade preferences

Indirect shipments to Australia may result in the loss of a trade preference

Operationally, the information regarding origin may be lost in the consolidation process.

The Asia Pacific region is often described as a spaghetti bowl of overlapping free trade agreements. This situation will become more complex with the conclusion of free trade agreements with Japan and Korea.

All free trade agreements contain rules regarding whether goods must be directly shipped from the country of origin to Australia to maintain their preferential treatment. The difficulty with multiple free trade agreements is that there is no uniform set of rules. Under one agreement, indirect shipment and offshore consolidation will not result in the goods losing their preferential status. Preference under other agreements depends on whether the goods are stored in a bonded warehouse or the extent to which they are altered. The key is to be aware of the complexities involved in trade preferences and to have a system in place to ensure that preferences are only claimed where available.

At the same time, it is not unusual for importers to simply abandon all trade preferences when goods pass through an offshore DC. While this may be a zero risk approach, the importer may be overpaying duty.

Customs value

The customs value of goods impacts the customs duty and GST payable on importation. Depending on the supply chain structure, a regional DC may act as a buy/sell entity.

Where this is the case the customs value should usually be based on the DC’s sale price. Issues can arise firstly regarding whether that markup is being included in the customs value and, secondly, if it is, is it an arm’s length mark up?

From a customs perspective, it is generally not acceptable for an offshore buy/sell entity to simply on sell at the original manufacturer’s price. At the same time, some companies are achieving customs duty savings by:

Having the offshore buy/sell company act as a non-resident importer

Considering alternative customs valuation methodologies

Changing its role to a buying agent.

These methods may help reduce the customs impact of interposing an entity in the supply chain. There are as many solutions as there are different supply chain models. It is critical for a company to review their unique situation.

Customs invoice, proforma invoice and electronic invoices

A consolidated shipment may comprise many partial or full orders from different suppliers. In these circumstances it is common for a DC to issue a “customs invoice”, “proforma invoice” or “electronic invoice” listing the price of each good shipped instead of providing the customs broker with the multiple original supplier invoices.

This is an acceptable practice, provided that the price on the DC generated invoice reflects the correct customs value, and that the DC generated invoice can be easily reconciled with the sales price actually paid by the Australian importer.

Customs has released a fact sheet on this issue noting that such invoices have been found to be highly inaccurate in a significant number of cases.

Where a DC produces an invoice for shipping purposes, careful attention should be paid to whether the Australian importer can prove that the document reflects the commercial invoice amount, and the amount paid by the supplier. Where it does not, there is the risk of a systemic problem.

Packing costs

Even where the DC performs a purely logistical function, and does not buy/sell the goods, the activities performed by the DC may impact on the customs value of the goods. This will clearly be the case for countries that base their customs value on the CIF value of the imported goods. However, even for Australia where the cost of international freight is excluded from the customs value, it is necessary to consider the extent to which DC costs are a packing cost.

Customs will argue that some activities, such as placing goods in cartons, are clearly dutiable packing costs, while other activities will be duty-free international freight costs.

Border security and cargo reporting

Border security and the security aspects associated with reporting the arrival of consolidated shipments is at the forefront of Customs’ compliance agenda.

The issue with consolidated shipments is that each consolidated container may contain goods from a variety of suppliers, possibly to multiple Australian recipients. Customs generally requires a separate cargo report in respect of each supplier/recipient combination. This means that multiple cargo reports may be required for each consolidated shipment. However, it is common practice for some in the industry to only lodge the one cargo report.

In its latest compliance update, Customs noted that of the cargo reporting errors it detected, approximately 75% related to the issue of not correctly identifying the supplier or recipient of the goods. It also reported issuing infringement notices with respect to false statements in a cargo report.

Customs compliance cannot be ignored. It is appreciated that complying with Customs’ demands could significantly increase supply chain costs, and result in additional administrative work. We are helping clients work with Customs to provide solutions that address Customs’ security concerns while supporting supply chain efficiencies gained through offshore consolidation.

Managing the various issues

Companies need to take a wide-ranging view of the customs issues that impact off-shore consolidation. Such review will need to balance the competing demands of operational efficiency, lowering customs value and customs compliance.

Various stakeholders will have different priorities. In our view, poor customs compliance is the biggest threat to a company’s supply chain. This will become more so following the proposed introduction of a trusted trader program where Customs will reward compliance with access to trade facilitative measures.

With its significant cost savings, off-shore consolidation is here to stay. The task of advisors is to ensure supply chains are customs compliant without having a negative impact on customs costs or operational efficiency.